Power Dynamics of a U.S.-China Trade War

As President Donald Trump travels through Asia he seems, on the surface at least, to be placated by the flattering treatment he receives from world leaders. Statesmen such as Japanese Prime Minister Shinzô Abe and Chinese President Xi Jinping have already demonstrated their skill in massaging Trump’s ego during previous visits to Washington. Since the Trump administration still has not filled many high-level positions in the government, including the top Asia-related jobs in various departments, there may not be enough experts on staff for these summits to lead to anything of substance. It might be enough for Trump’s idea of success that he gain some positive press coverage. Yet beyond the niceties there remains potential for a U.S.-China trade clash.

The most cynical view of Trump’s interest is that he aims to achieve very little, so any superficial boost to his ego he may count as a victory. In that interpretation, the issues he campaigned so strongly for during the presidential race were actually of no particular concern to him, but just empty promises to win the election, thereafter quickly forgotten.

Indeed, on the surface, this seems true of Trump’s Asia policy. Among the first things he did in office was to withdraw from the 12-nation Trans-Pacific Partnership multilateral commercial agreement, a controversial and significant step. Since then he has done very little to change U.S. relations with East Asia, other than increasing sanctions on North Korea and speaking and tweeting belligerently about its ambitious missile and nuclear weapons programs, though these actions have failed to deter North Korean leader Kim Jong Un.

However, as I argued recently, Trump remains serious about an agenda that includes two items that roil relations in the region, particularly with China: He wants to rebalance trade to increase U.S. exports to, and decrease imports from, Asia, and he wants to eliminate North Korean nuclear weapons. Trump remains attached to these goals because he needs to restore his flagging political support in the U.S. He is not a normal president content with keeping the peace and maintaining adequate prosperity. He is an insecure and unpopular president under existential threat from multiple investigations that could not only end his political career, but also undercut his business. He needs to do more than just muddle through. He needs a big win to have any hope of staving off powerful political opposition. The key referendum on his performance will be the 2018 midterm election, where significant gains by the Democratic Party in Congress could increase his danger of impeachment.

There are some parallels with the situation President Richard Nixon faced in 1972 with a failed war in Vietnam. Nixon’s political recovery that year came from his surprise opening of relations with Mao’s China, detente with the Soviet Union, and the “October Surprise” announcement that “peace is at hand” in Vietnam. All these peace initiatives distracted from his domestic troubles, including the Watergate investigation that ultimately forced his resignation in 1974.

Nixon was hobbled domestically by opposition from a Democratic Party majority in both houses of Congress. Despite the Republican majority in both houses today, Trump has no less trouble with Congress because of divisions within the House Republicans and outspoken opposition to Trump among key Republican senators. As with Nixon, since it is hard for Trump to pass legislation through a rancorous Congress, if he can boost his popularity, it must be in the foreign policy arena where the president has considerable autonomy.

Although Congress has broad power over issues of foreign trade regulation, Trump has already taken steps to enhance his power to enact trade sanctions against China without Congressional action by initiating a Section 301 investigation of Chinese intellectual property theft. Using this process gives him legal authority to enact punitive tariffs on China if he desires. If he does not use this power, he looks weak and fails to score in an area he claimed during the presidential campaign is of vital importance to the prosperity of America. On the other hand, if he does use this power, he faces the almost certain prospect of disruptive Chinese retaliation, the start of a trade “war.” It is not at all evident that Trump would benefit politically from initiating trade actions against China, but he may not be aware of the risks either.

Much of the press has emphasized that Xi’s power was enhanced by the recently concluded 19th Congress of the Chinese Communist Party. Yet, as I argued last week, Xi’s challenges are also considerable. China’s economy has grown enormously in recent decades, but growth is slowing and is now sustained only by ballooning debts. China needs to adapt its economy from an emphasis on exports and investment (including construction) to more stable consumer-driven demand. But the required reforms are not easy to implement in the face of widespread corruption and a divergence between the central government, led by Xi, and local governments all over China. The latter have a more bullish interest in continuing to expand credit to fuel local real-estate booms, one of the principal engines of Chinese growth.

Excessive expansion of credit tends to weaken the Chinese currency, the RMB. In fact, its dollar value peaked in 2014 and has trended slowly downward since then. The falling value of the RMB concerns the central government because it might accelerate the growing outflow of capital abroad. Wealthy Chinese people and businesses may increasingly prefer to position their wealth in foreign currencies that better maintain their value. The Chinese government is very aware of the example of Russia, which suffered a massive increase in corruption and outflow of capital as its ruble fell in value, particularly during the late 1990s. Many Russian businesses were stripped of funds that flowed abroad into the private accounts of newly rich oligarchs. The stability of the RMB and Chinese trade are not merely an economic concern for China’s leaders, but a critical political issue.

Strong export success also helps keep the RMB from falling. If China were to accede to Trump’s demands and significantly increase imports from the U.S. while decreasing exports to the U.S., China’s foreign currency earning from trade would decrease. Combining this with the excessive credit expansion required to maintain the real-estate boom would result in heavy pressure for the RMB’s dollar value to fall. This could provoke the kind of exchange rate crisis that periodically afflicts many developing countries. Stability for China requires the massive trade surplus with the U.S. that Trump blames for “stealing American jobs.”

Trump claimed during the campaign that he would impose high tariffs on Chinese exports if necessary to balance imports and exports. Section 301 gives him the legal power to do this. If he follows this course, China must, to stave off the collapse of the RMB, begin selling its massive reserves of dollar assets, many in the form of U.S. government bonds known as Treasuries. Selling dollar assets to buy RMB tends to prevent the fall of the value of the RMB relative to the dollar. If global markets are flooded with Chinese sales of Treasuries, their price will drop, increasing U.S. interest rates. Increased cost of borrowing in the U.S. would certainly slow down the economy if not cause an economic crash. As in any economic policy, there would be both winners and losers in such a crash, particularly among the elite, but it would be a false hope for Trump to expect popular political gains from a slowdown, if indeed he understands the consequences of his actions.

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James H. Nolt is a senior fellow at the World Policy Institute and an adjunct associate professor at New York University.